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'significant inventory overhang'

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Lex: US housebuilders

Published: May 23 2006 19:28 | Last updated: May 23 2006 19:28

Feeling sorry for the builders does not come naturally to most homeowners. But as US households worry about the value of their dwellings, they might spare a thought for those even less fortunate. Since July last year, shares in US homebuilders have lost over a third of their value.

Things have been most painful at the top end of the market. Shares in Toll Brothers, the luxury homebuilder, have more than halved. Over the past few months, the question for most investors has changed from whether there will be a slowdown, to how bad things could possibly get.

Already, there are signs of a significant inventory overhang in many regions. Speculative buyers are feeling the squeeze from higher interest rates and many are trying to rid themselves of their holdings. Owners hoping to move up the housing ladder are having trouble selling their old homes at the prices they expected. Most builders, meanwhile, have tended to just keep on building.

On all these issues, Toll serves as a bit of a bellwether, thanks to its sophisticated clientele. Sentiment has grown so negative that the latest cut in its guidance actually helped trigger a relief rally. After all, its valuation remains well below what the land and inventory it holds should be worth. Unfortunately, the same is true of many listed builders, who are pretty much the only potential buyers of half-finished building sites.

With the sector as a whole trading at about 5.5 times shrunken earnings estimates for the year, it certainly looks cheap on more conventional measures as well. But costs are going up and consolidation is probably still some way off. That will make it hard to defend the recent high returns on capital in leaner times.

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